CFA Level II ExamFinancial Statement AnalysisMedium
A U.S. company (reporting currency USD) is preparing its consolidated financial statements. It has a foreign subsidiary operating in a country with a stable economic environment, and the subsidiary's local currency (LC) is its functional currency. During the year, the subsidiary reported net income of 500,000 LC. The average exchange rate for the year was 1 LC = 0.85 USD, and the year-end exchange rate was 1 LC = 0.88 USD. What amount should the parent company report as the subsidiary's net income in its consolidated income statement?
- AUSD 450,000
- BUSD 425,000
- CUSD 440,000
- DUSD 430,000
Show answer & explanationAnswer & explanation
Correct answer: B. USD 425,000
Since the subsidiary's local currency is its functional currency, the current rate method is used. Under the current rate method, income statement items, including net income, are translated using the average exchange rate for the period. Therefore, 500,000 LC * 0.85 USD/LC = 425,000 USD.
Why the other options are wrong
- A. This would be an arbitrary rate or a miscalculation.
- C. This would be using the year-end rate, which is incorrect for income statement items under the current rate method (500,000 LC * 0.88 USD/LC = 440,000 USD).
- D. This would be an arbitrary rate or a miscalculation.
Current Rate Method - Income Statement Translation
Under the current rate method, when a foreign subsidiary's functional currency is its local currency, all income statement accounts (revenues, expenses, gains, losses), including net income, are translated into the parent's reporting currency using the average exchange rate for the reporting period.
- Used when functional currency is local currency.
- Income statement items translated at average rate.
- Reflects economic activity occurring evenly throughout the period.
- Translation adjustment (OCI) arises from balance sheet translation.
Memory trick: Current Rate: 'All Current' for Balance Sheet, 'Average' for Income.